Foreclosures and Banks' Debt to Society

The mortgage debacle in the United States
has raised deep questions about "the rule of law", the universally
accepted hallmark of an advanced, civilized society. The rule of law is
supposed to protect the weak against the strong, and ensure that
everyone is treated fairly. In America, in the wake of the subprime
mortgage crisis, it has done neither.

Part of the rule of law is
security of property rights - if you owe money on your house, for
example, the bank can't simply take it away without following the
prescribed legal process. But in recent weeks and months, Americans have
seen several instances in which individuals have been dispossessed of their houseseven when they have no debts.

To
some banks, this is just collateral damage: millions of Americans - in
addition to the estimated 4 million in 2008 and 2009 - still have to be
thrown out of their homes. Indeed, the pace of foreclosures would be set
to increase - were it not for government intervention. The procedural
shortcuts, incomplete documentation and rampant fraud that accompanied
banks' rush to generate millions of bad loans during the housing bubble
has, however, complicated the process of cleaning up the ensuing mess.

To
many bankers, these are just details to be overlooked. Most people
evicted from their homes have not been paying their mortgages, and, in
most cases, those who are throwing them out have rightful claims. But
Americans are not supposed to believe in justice on average. We
don't say that most people imprisoned for life committed a crime worthy
of that sentence. The US justice system demands more, and we have
imposed procedural safeguards to meet these demands.

But banks want to short-circuit these procedural safeguards. They should not be allowed to do so.

To
some, all of this is reminiscent of what happened in Russia, where the
rule of law - bankruptcy legislation, in particular - was used as a
legal mechanism to replace one group of owners with another. Courts were
bought, documents forged,
and the process went smoothly. In America, the venality is at a higher
level. It is not particular judges that are bought, but the laws
themselves, through campaign contributions and lobbying, in what has
come to be called "corruption, American-style".

It was widely
known that banks and mortgage companies were engaged in predatory
lending practices, taking advantage of the least educated and most
financially uninformed to make loans that maximized fees and imposed
enormous risks on the borrowers. (To be fair, the banks tried to take
advantage of the more financially sophisticated as well, as with securities created by Goldman Sachs that were designed to fail.) But banks used all their political muscle to stop states from enacting laws to curtail predatory lending.

When it became clear that people could not pay back what was owed, the rules of the game changed. Bankruptcy laws were amended to introduce a system of "partial indentured servitude".
An individual with, say, debts equal to 100% of his income could be
forced to hand over to the bank 25% of his gross, pre-tax income for the
rest of his life, because the bank could add on, say, 30% interest each
year to what a person owed. In the end, a mortgage holder would owe far
more than the bank ever received, even though the debtor had worked, in
effect, one-quarter time for the bank.

When this new bankruptcy
law was passed, no one complained that it interfered with the sanctity
of contracts: at the time borrowers incurred their debt, a more humane -
and economically rational - bankruptcy law gave them a chance for a
fresh start if the burden of debt repayment became too onerous.

That
knowledge should have given lenders incentives to make loans only to
those who could repay. But lenders perhaps knew that, with the
Republicans in control of government, they could make bad loans and then
change the law to ensure that they could squeeze the poor.

With
one out of four mortgages in the US under water - more owed than the
house is worth - there is a growing consensus that the only way to deal
with the mess is to write down the value of the principal (what is
owed). America has a special procedure for corporate bankruptcy, called Chapter 11, which allows a speedy restructuring by writing down debt, and converting some of it to equity.

It
is important to keep enterprises alive as going concerns, in order to
preserve jobs and growth. But it is also important to keep families and
communities intact. So, America needs a "homeowners' Chapter 11".

Lenders
complain that such a law would violate their property rights. But
almost all changes in laws and regulations benefit some at the expense
of others. When the 2005 bankruptcy law was passed, lenders were the
beneficiaries; they didn't worry about how the law affected the rights
of debtors.

Growing inequality, combined with a flawed system of
campaign finance, risks turning America's legal system into a travesty
of justice. Some may still call it the "rule of law", but it would not
be a rule of law that protects the weak against the powerful. Rather, it
would enable the powerful to exploit the weak.

In today's
America, the proud claim of "justice for all" is being replaced by the
more modest claim of "justice for those who can afford it". And the
number of people who can afford it is rapidly diminishing.